Defining the Concept of Bad Faith in Contract Law
In the context of contract law, bad faith is a violation of a duty to deal fairly and honestly in the performance and enforcement of the contract. With an expectation that the deal must be honest, both parties must refrain from taking advantage of the other.
In the insurance industry for example, bad faith can occur when an insurer refuses to provide compensation in accord with the contractual benefits of the policy. Although insurance companies are in the business of making money, they must also comply with the terms of the contract. If for instance, an insurer refuses to settle a claim in good faith and instead, chooses to litigate the claim resulting in exposing the insured to greater losses, then the insurer may have committed bad faith.
In other situations, for example, if a contractor sells a new home and agrees to install a new roof but then refuses to perform work to address a leak because the owner chose to not use him for the installation, bad faith can be considered . Even though the contractor performed the roof, he is still subject to liability because his actions caused another loss outside of the structure of the contract. The damages incurred due to the leak would be direct damages as a result of bad faith.
As such, damages for bad faith can range between direct and consequential. Direct damages are usually incurred in the form of economic damages as a result of bad faith, while consequential damages consist of emotional harm or pain and suffering.
What constitutes bad faith: whether it is in the insurance industry or in general contract performance, the most recognized law states that a party should not take unfair advantage of another. As such, if for example, one party performs better than they were required under the conditions of the contract, they may arguably be relieved of damages in the long run. Thus, there is a fine line between meeting and exceeding expectations.
How to Detect Bad Faith in Contracts
The manifestations of bad faith are many and varied, and can even include neglecting a contractual obligation. However, there are some recognizable behaviors that can help in identifying a bad faith party in a given case. Failure to meet obligations, such as an unreasonable delays, inadequate performance, or lack of transparency, can be characteristic of dishonesty. Failure to provide requested documents is another common sign; parties that wish to avoid discovery or desperately seek to keep information from the other side could be guilty of bad faith. Evading contractual requirements is also suggestive of bad faith. This includes attempts to re-negotiate contractual provisions once they have been agreed to, such as attempting to re-negotiate due dates, repeating or extending deadlines or deadlines, and breaking joint ownership agreements. Other signs of bad faith can be expressed through the tone of correspondence and negotiation tactics. Things to look out for include belligerence, inconsistency in statements, inability or unwillingness to keep promises, large swings in settlement demands, and mistrust.
Consequences of Bad Faith in the Eyes of the Law
Parties found to be acting in bad faith may face legal consequences and significant damages under Louisiana law. In contractual and civil law contexts, actions demonstrating bad faith may give rise to penalties, both pecuniary and injunctive. In this way, courts may penalize acting in bad faith and limit the impact of that underlying conduct.
Contractual Actions
Civil law penalties are available for parties found to act with bad faith in the performance or enforcement of a contract. In addition to the award of damages to the non-bad-faith party, a court may also decree a fine and payment of attorney fees.
Article 1997, an anomaly in Louisiana law, is the only Civil Code article that expressly recognizes Louisiana statutory penalties in conjunction with bad faith. The Article may be made applicable to tort actions or contractual negligence actions, as long as there is a contractual breach. Civil, statutory penalties are appropriate, however, only when the breach of contract involves a deliberate intention not to perform the contractual obligation.
In addition to the penalty of damages, a court may award a fine to the injured party equal to an amount of two times the underlying damages, plus reasonable attorney’s fees.
Judicial Actions
In addition to contract-based penalties, civil law actions allow a court to penalize abusive litigation tactics and other bad-faith behaviors. Such actions may include misusing the judicial system by bringing unfounded, harassing or frivolous lawsuits or defenses, knowingly filing inaccurate documents in judicial proceedings, and filing frivolous motions for rehearing or reconsideration.
Penalties include attorney’s fees of up to $2,500, damages, punitive damages and an injunction, which prevents a party from re-offending in the future. If the subject of an injunction has a material effect on the public interest (e.g., product safety, environmental concerns), a penalty may be doubled.
Bad Faith and Contract Violations
Acting in bad faith refers to the intention and willingness to do an act with the intention of defeating another party in regard to their rights and obligations. Every act of contract ultimately has an implied covenant to act in good faith and to deal fairly with each party to the agreement. In other words, an individual who acts in bad faith would perform acts without showing the intention to fulfill the contract. Someone acting in bad faith could try to gain an advantage or profit for him or herself at the other parties’ expense. Without the obligation to act in good faith, contracts would be nearly useless. There would be little incentive to honor the contractual promises made amongst the parties. Therefore, all contracts could be voided by one party simply because it was in their best interests. Bad faith would essentially eliminate contracts when it comes to the enforcement of contractual promises. The bad faith doctrine encourages the parties to honor agreements and be fair with one another. The courts have interpreted and applied the duty of good faith and fair dealing in an array of legal suits. One example of bad faith is that if the assenting party to the contract misrepresented the terms, conditions, and/or details of the contract in order to induce acceptance by the other party. The duty to act in good faith and fair dealing exists to protect the expectations and spirits of the parties to the contract. Breach of contract is slightly different from acting in bad faith. A breach of contract occurs when a party fails to honor and comply with the duties of the contract. Bad Faith is a close cousin of breach of contract, but the two are not synonymous. Breach of contract is a general term used for any situation where a party to a contract fails to perform his or her contractual promise. Bad faith, however, is a specific type of breach of a contract. Nationally, there is no general consensus on whether a cause of action for bad faith breach of contract should exist separately from breach of contract. Many courts have allowed for a claim for bad faith breach of contract in the context of insurance contracts. The relationship between the duty of good faith and fair dealing and breach of contract is not clear cut. Breaching a contract’s express terms is not necessarily a breach of the implied covenant not to act in bad faith. Many courts, however, have expanded the protection against acting in bad faith to preserve the spirit of enforcing contractual duties. Courts have granted relief for breach of the covenant of good faith and fair dealing notwithstanding the absence of any breach of an express term of the contract. Breach of this implied covenant not to act in bad faith permits a broad range of recovery for aggrieved parties.
How to Avoid Bad Faith in Contract Agreements
To guard against instances of bad faith, it is important to bear in mind several best practices during the negotiation and drafting process of contracts. One of the most effective methods of combating claims of bad faith is to include clear terms and conditions in the contract itself, which will make it difficult for either party to claim otherwise.
One strategy to consider is to specifically set out the steps that must be taken if either party feels as though the other is acting in bad faith, and the extent to which they should or may be able to pursue litigation or other dispute resolution options .
Additionally, when negotiating the material terms of the contract, it is important to work out hypothetical scenarios that may arise over the course of the deal, whether a deadline has been set, which party is likely responsible for what, etc. By discussing these types of issues up front, both parties to the contract will have a better idea of what to expect as the deal moves forward.
At the end of the day, even with the most precise legal terms and strategic hypotheticals, there is no way to absolutely protect against a bad faith party. When entering into a contract, however, it is key to know whether or not it has been negotiated in good faith and whether you have the ability to litigate or mediate in the event that this occurs.
Scenarios: The Manifestation of Bad Faith
When a contract is breached, the aggrieved party typically has the right to seek damages. But in some cases, compensatory damages fail to remedy the wrong committed. In these situations, a court may award other remedies, including punitive damages. Although awarding punitive damages is far more rare, there are scenarios when they are appropriate. They are generally only awarded for egregious conduct, such as behavior defined as bad faith or done with malice and a disregard for the victim’s safety or well-being.
In the insurance context, some courts have found that bad faith was present depending on how the insurance company handled the claim process. For example, in Hurley v. Physicians Mutual Insurance Company, a surgeon covered by the policy sought reimbursement for a medical malpractice judgment. The insurer asked for a written summary of the surgeon’s case from the plaintiff’s attorney. Rather than send an internal statement, however, it simply turns over the entire file of the defense attorney. The plaintiff’s attorney included statements and information about the surgeon’s practices that were unrelated to the incident for which coverage was sought. The court found the insurance company had produced documents that were irrelevant to the claims, hindering the other lawyer in the ongoing litigation and demonstrating bad faith.
As another example, in Allstate Insurance Company v. Repass, the court held that an insurer’s refusal to obey a court order to pay compensatory damages after a jury verdict constituted bad faith. The action involved a motorcycle accident that was not covered by the plaintiff’s policy. Nevertheless, Allstate had made an offer to settle the case. After the case was tried, the jury rendered a verdict in favor of the plaintiff in the amount of $745,000. The insurer refused to pay, arguing that the policy was void due to a technicality. When the case went to trial, the jury also awarded $5 million in punitive damages. The Arkansas appeals court affirmed the award for punitive damages for bad faith.
Bad faith is alleged in other contexts as well. In World Wide Auditing Services, Inc. v. Kilbride, the plaintiff filed a lawsuit in Colorado (where it was incorporated), even though all the transactions at issue took place in Michigan. The Michigan Supreme Court agreed the lawsuit should be dismissed because it would be an improper exercise of jurisdiction.
These cases demonstrate how broadly the doctrine has been applied in the commercial context, and how it has evolved over time. In Mid-Continent Broadcasting v. State of Illinois, the Illinois Appellate Court upheld a $1.5 million punitive damages award stemming from wrongful termination, despite the absence of an explicit termination provision in the contract. The court cited a common law principle, as well as academic commentary, to find that this action evidenced bad faith.
In Goodwin v. Elbin, a 1954 case arising from a broken lease, the Delaware Supreme Court rejected the notion that bad faith existed only in cases in which one party maliciously placed himself in a position to be taken by surprise at the expense of the other, finding that the breach of an implied contract term supported the award of punitive damages. Later, the Third Circuit rejected an allegation of bad faith based on a similar implied contract term. In Ludlow’s World Corp. v. CareerStep, Inc., the Third Circuit reversed that decision and again applied the good faith duty.
The Good Faith Doctrine is not a "one size fits all" rule. It must be evaluated and applied on a case by case basis in accordance with governing state law. The circumstances of a given transaction and the admonition to be fair in all dealings must be considered to determine if contractual duties have been violated to the extent to invoke the remedy of punitive damages.
Bad Faith Revisited: The Realm of Global Contracts
Similar to domestic contract law, most jurisdictions recognize a common law principle of good faith in international contracts as well. However, the application of the doctrine varies significantly between jurisdictions. For example, the United States recognizes an implied oral agreement, specifically to protect the reasonable expectations of the parties contained within contracts in general, while Canada recognizes the duty of honest contractual performance.
In terms of multicultural or international agreements, many manufacturers will include a choice of jurisdiction clause to avoid such problems between relevant provisions , languages, and cultural or legal norms as to what is permitted or not.
The consideration of bad faith in the drafting of international or multi-jurisdictional agreements cannot be understated, and it is important that legal professionals have an understanding of where and how their contract language might be interpreted. In addition to having the language for the contract reviewed in multiple jurisdictions, businesses should consider having the entire contract reviewed by counsel in relevant jurisdictions, especially when entering into a multinational contract.